Economic Myth Busters

If the money the government lays out doesn't get spent—if it just
gets added to people's bank accounts or used to pay off debts—the
plan will have failed.
—Paul Krugman (New York Times, Jan. 25, 2008)

Upon receiving income, consumers face two choices. They can spend
their income, or they can save it. A widespread belief is that
consumers must spend income to help the economy and that if people
choose to save, the economy suffers. An economy is built on
consumption, and too much saving detracts from growth. If people are
saving their income, then they are not buying new things or paying
for services, which help keep people employed, businesses running and
the economy growing. The tax rebate checks sent out in 2008 were
intended to help keep the U.S. economy out of a recession. Taxpayers
were encouraged to spend the rebate rather than save it, which is
right in line with this belief. Saving will not help as much as
consumption in an attempt to avoid recession.

The truth is that saving does benefit the economy—consumers
themselves are not spending their income, but their savings serve as
secondary investments. There are many ways to save, including in a
savings account at a bank or as an investment in the stock market,
investing in a relative's small business, government bonds or
certificates of deposit. Each of these methods is a way for consumers
to save, but also allows others to invest saved income.

Saving provides an important source of capital to banks and
companies. In particular, banks utilize consumer savings to make
loans to individuals or companies, and public companies use consumer
investments to build factories, hire new employees, research new
products and so on. Saving drives all of the above. If an individual
wants to take out a loan to buy a car, the bank can use the savings
of consumers to make a loan to that individual. When a bank makes a
loan, the person or business receiving the loan will spend the money,
which is the secondary spending that takes place to aid economic
growth. However, it may take time to make this investment and for the
effects of the investment to roll through the economy.

Saving in the present creates stronger spending in the future. When
consumers save, they earn interest on their savings and experience
appreciation on their investments. When interest is received and
profits are made, consumers have more income to spend than they had
prior to the investment. When U.S. taxpayers received their tax
rebate checks, spending them immediately may have had the greatest
effect at the present; however, saving that check would have accrued
interest and appreciation, creating greater spending power in the
future.

The only form of saving that does not benefit the economy is saving
that cannot be used by a secondary institution, such as a bank or
public company, or if the secondary institution does not invest the
proceeds. An example of this form of unbeneficial saving is storing
money under a mattress. In such a case, a consumer's savings are not
earning interest, nor can a secondary institution utilize those
savings as a secondary investment. Not only are consumers not earning
interest on their income, but they are also losing value to
inflation. To lessen the effects of inflation, consumers and
financial institutions should use funds in such a way that they
expect to earn a return on investment.

While saving may not appear to be as helpful to the economy as direct
consumer spending, saving does provide a number of benefits.
Economies must strike a healthy balance between consumption and
saving, and a certain degree of saving is beneficial for every
consumer. Consumers must determine their own level of saving based on
how much they are willing to give up at the present for future
consumption. While immediate consumption may provide the greatest
economic benefit at the present, consumers should never avoid saving
in fear of stunting economic growth.